I get some variation of this question on a regular basis and it usually falls into one of 2 scenarios. The first is when someone is getting ready to retire. The other is when a mid-career family is buying a new home, thinking about refinancing, or has just come into some additional money, say from a promotion or inheritance. For the sake of brevity, I’ll cover the first scenario here and the other in a future post.

While every situation is different and there are multiple factors to take into account, let’s look at a relatively common example. First a quick disclaimer – nothing I discuss here should be taken as personal advice. Everyone’s situation is unique. If you’re looking for assistance then I recommend consulting with a qualified professional who knows your complete financial picture.

**I Thought I Left These Math Story Problems back in Algebra**

Let’s suppose you are about to retire. You have lived in your home for the past 20 plus years and don’t plan on moving. You originally borrowed $150,000 on a 30 year, 7% mortgage in the mid-90’s and have steadily made the $1,000 monthly payment.

Now you have a balance of $50,000 and 5 years remaining on the loan. You have more than enough savings so that you could pay the mortgage off entirely. But should you do that? Your investments took a big hit in 2008 and have finally come back. In fact, they’ve been doing pretty well for the past 4-5 years. If you took the money out of your savings and your investments continued doing well, you’d be giving up on potential profits had you stayed invested.

Also, back in 2010, when interest rates dropped to 5%, you thought about refinancing. Even though your monthly payment would have gone down quite a bit, you decided against it as the mortgage would have started over again for another 15 or 30 years and it didn’t seem worth the hassle.

Now with retirement approaching, you’re thinking it would be nice to have either a smaller monthly payment or no payment at all. What should you do?

- Take money out of your savings and pay off the mortgage
- Refinance the balance for 15 years to get a smaller monthly payment
- Keep making your regular monthly payments to pay off the mortgage in 5 years.

**So, What’s the Answer?**

As with loading a dishwasher, there is usually more than one way to reach a goal. In this instance a case could be made for choosing option 1 or 2. Option 3 is sub-optimal because of the interest rate on the current loan. Both options 2 and 3 allow you to keep the $50,000 loan balance invested. However, since 2 has the lower interest rate, instead of needing more than a 7% return to come out ahead, you would only need to average better than 3.25% yearly on your investments.

So now we’re down to either writing one check or refinancing the balance for 15 years. And, without knowing what the markets will do over the next 15 years, the correct answer from a pure financial analysis is uncertain.

# The Emotional Component

However, because we are human there is another aspect to take into account, our emotions. No doubt some of you are saying to yourselves, there is such a high likelihood that I’ll make more than a 3.25% return on my investments over the next 15 years the correct answer would be to refinance. Others of you are thinking that regardless how low the monthly payment is, you would sleep better knowing that the mortgage is gone. From my standpoint, I’ll say this:

“I’ve never had someone who paid their mortgage off early tell me they wish they hadn’t done it.”

**Another Option: Hedge Your Bets**

Instead of making the either/or decision, you decide on another approach. Although it would be nice to have the mortgage paid off, you also think it is likely that the investments will do better than 3.25% over the next 15 years.

So you go ahead and refinance. Then, on a regular basis, you will review the growth on the $50,000. If you have a profit, it is used to pay down the loan balance. If the account is down, you will wait for it to come back. And you feel comfortable knowing that at any time you can decide to pay the loan off entirely.